QUESTION: I have been running a family business for years and have considered incorporating. With the recent rise in corporation tax rates, I’m not sure if it is the right thing to do. Can you advise if I should incorporate?
ANSWER: There are many important decisions to make when you own a business, and deciding on your structure is one of them. As you already run a business as a sole trader, there may come a time when incorporation is the right thing to do.
Incorporation has several benefits for business owners – the main advantages are regarding the overall tax rates suffered. But that doesn’t mean it’s without its drawbacks, so here’s everything you need to know about incorporating your business.
First and foremost, many business owners choose to incorporate their business for tax purposes. Corporation tax rates applicable to companies (currently 25 per cent for companies with profits above £250,000) compared to income tax rates for unincorporated businesses varying from 20 per cent to 45 per cent plus Class 4 and Class 2 NIC contributions.
However, the profits are taxed again if you take them out of the company to spend on personal expenses, therefore incorporation rarely makes sense if you plan to extract all profits from the business each year. Though business owners have a degree of flexibility in that they can pay themselves with a mix of salary and dividends.
You will have the ability to pay yourself under the personal allowance of £12,570 a year and not have to pay any income tax. You can then top this up with dividends which HMRC taxes at a lower rate than income tax (currently 0 per cent, 8.75 per cent, 33.75 per cent and 39.35 per cent). The company will get relief from corporation tax on the salary paid to the business owner, but not for the dividends extracted by the shareholder.
This leads us into the next point to consider. The limited company has a separate legal entity from the owners. If you own an unincorporated business, there is no separation of identity. One of the big benefits of operating through a limited company is limited liability. This can give protection to business owners compared to operating as sole-trader or a partnership. Sole traders are legally and financially responsible for their business. If their business makes a loss or incurs debt, they’ll be responsible for settling these issues. But as a company director with limited liability, your personal assets will most likely be protected beyond what you personally invested in the business.
Setting up a company as a single shareholder is relatively simple and straightforward. However, if there are other shareholders involved things can become more complicated. In order to give the correct level of protection, a shareholder’s agreement and employment contracts are extremely important.
Additional tax benefits are also available to companies, that sole traders to not get. If your business is involved in research & development, has registered a patent or a licence to exploit a patent then they are able to reduce their taxable profits or benefit from a reduced rate of corporation tax. In addition to this, corporate structures can give more flexibility when businesses are expanding and growing and there are various tax reliefs available to assist businesses with this.
Although becoming a limited company sounds like the easiest and best option, it does have certain costs. One of the most impactful changes will be the amount of administrative paperwork you’ll have to take on. For instance, you’ll have to file statutory accounts with Companies House every year along with other statutory documents, all of which come with an additional financial cost.
If you wish to run your business with a level of privacy, incorporating may not be the option for you. As you’ll be on the company’s register, your company’s financial information will be readily available to the public. Furthermore, setting up a limited company may mean you have to relinquish a certain amount of control; if you have fellow directors and shareholders, you won’t be able to make any
significant decisions without their approval. Many people decide to get into business to be their own boss, but with incorporation, you may have to share the reins.
During the incorporation planning stage there are a number of factors that need to be considered, which could have legal, commercial, accounting and tax implications. Getting it wrong at this stage can be very costly. One typical area that needs to be considered in detail relates to property. If you own business premises, the options will be, should the property remain in personal ownership, or should it be transferred to the company?
If transferred to the company, what is the value of the property, are there any capital gains tax and stamp duty implication and can these be mitigated in anyway? If the property is remaining in personal ownership, then you may need to consider, charging a rent to the company as a means of extracting income from the company, however, this could impact on future capital gains tax and inheritance tax reliefs as well as the salary dividend strategy discussed earlier.
Incorporation could offer more flexibility, security and seem like the best option, however we would advise speaking to your trusted UK tax adviser.
:: Feargal McCormack (email@example.com) is partner at FPM Accountants Ltd (www.fpmaab.com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies